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In our first two articles in this series, we introduced the new Civil Transactions Law of the Kingdom of Saudi Arabia (referred to as the “KSA Civil Code”) and provided analysis of its key provisions relevant to forming contracts.[1]
In this article, we consider the impact of the KSA Civil Code’s key provisions of particular interest to parties engaging in construction contracts in Saudi Arabia. These include both general contractual principles, as well as specific provisions related to contracts for service, known as Muqawala contracts.
The KSA Civil Code includes a series of mandatory provisions (i.e. provisions which will apply regardless of what the parties say in their contract) which can be of direct relevance to construction contracts (and construction disputes). These include provisions relating to: (i) good faith and abuse of right; (ii) moderation of contractual damages; and (iii) relaxation or suspension of contractual obligations.
As discussed in our second article in this series, the KSA Civil Code has codified the Sharia law requirement for contracting parties to act in good faith. The KSA Civil Code requires the contract to be executed “in a manner consistent with the requirements of good faith.”[2] This requirement also extends to negotiations prior to entering the contract, as the KSA Civil Code states that a “party negotiating or terminating the negotiations in bad faith shall be liable for the damage incurred by the other party.”[3]
Examples of bad faith during negotiations include knowingly withholding substantial information and a lack of seriousness in negotiations.[4] In that regard, parties to a construction contract should be careful to ensure that in carrying out negotiations in respect of potential variation orders or extensions of time during the course of a project they do so on a good-faith basis. For instance, an employer who conducts negotiations with a contractor without any intention of recognizing what would be an otherwise valid entitlement may be found to have acted in bad faith.
The application of good faith will also apply to the parties’ performance of their obligations, and this can extend to situations in which a party has a contractual discretion or right which might otherwise appear to be unlimited. This relates closely to the requirement that a contractual right must not be abused.[5] The KSA Civil Code provides a non-exhaustive list of situations that will amount to an abuse of right, including:[6]
In that respect, there may be circumstances in which the employer’s exercise of a contractual right or discretion, such as to refuse approval of a piece of work, could be said to be abusive in some circumstances (e.g. if the work is otherwise compliant and the employer is seeking to use its refusal to approve as part of a wider negotiation strategy).
The KSA Civil Code also allows for the moderation of contractual compensation (or “liquidated damages”) in certain circumstances, regardless of what the parties have provided for in their contract,[7] namely:
These provisions may protect contractors and sub-contractors in the event an employer attempts to enforce a liquidated damages clause despite not suffering any loss or suffering a smaller actual loss than is represented by the contractual sum claimed.
Construction contracts will often set out in express terms the circumstances in which a party might be relieved of its obligations, such as by setting out a detailed regime for what is to be defined as a force majeure event and what the impact of such an event will be on the parties’ respective obligations. Article 125 of the KSA Civil Code also provides, in general terms, that a party shall not be liable for damages that arose due to circumstances beyond their control such as force majeure, the fault of a third party or the fault of their counterparty.
In addition, the KSA Civil Code provides for the potential to alter the contractual allocation of risk where exceptional unforeseen circumstance of a general nature occurs which will cause undue hardship on the obligor. Specifically, it permits an obligor such as a contractor to call on its counterparty promptly to negotiate changes to a term of the contract if the exceptional unforeseeable circumstances make performance of its obligation “burdensome for the debtor such as to threaten him with exorbitant loss” [emphasis added].[11] If no agreement can be reached between the parties, the court (or arbitral tribunal) can “reduce the burdensome obligation to a reasonable level.”[12]
The KSA Civil Code therefore provides for a third party to amend the contract’s allocation of risk in the event it is satisfied that the necessary conditions are met.
However, it is important to note that: (i) the event must be of a “general” nature, i.e. it cannot be limited to the circumstances of the specific project in question; (ii) the event must be unforeseeable; and (iii) the obligor must meet the high threshold of proving that it faces not just a loss, but an “exorbitant loss,” if it were to carry out the obligation. In addition, it is important to note that any request for negotiation will not permit an obligor such as a contractor to stop performing the obligation.[13]
The KSA Civil Code also provides parties with a further right to withhold performance of a contractual obligation “as long as the other contracting party refrains from performing its own obligation.”[14] This right can only be exercised when the corresponding obligation of the other party is due. In addition, the party seeking to withhold performance must be ready and able to carry out its own obligations.
For example, where an employer has not paid a contractor sums due, the contractor may be entitled to rely on this provision to withhold further performance, provided that the contractor is otherwise ready and able to continue with its obligations.
In addition to the mandatory general provisions described above, there are also specific provisions relevant to Muqawala contracts within the KSA Civil Code, as set out at Articles 461 to 478. While construction contracts usually can be expected to provide a comprehensive allocation of risk between the contracting parties, these specific provisions will supplement the parties’ agreement on certain matters in the event the contract does not address them.
Articles 463 to 466 provide for a series of obligations for the contractor (subject to the further agreement of the parties), including that:
The KSA Civil Code also requires that, once the contractor makes its completed work available to the employer, the employer must take over the work immediately.[19] This is important, as the employer’s taking over of the work is typically the point at which there is a transfer of responsibility for the underlying work (subject to any latent defects), and it also crystallises the employer’s statutory obligation to pay for the work.[20]
Articles 470 to 472 further provide for the various forms of compensation to which the contractor may be entitled, and the circumstances in which such compensation should be increased, including (i) unit rates under Article 470; (ii) lump sum pricing under Article 471; and (iii) “fair remuneration” in the (unlikely) absence of a contractual pricing regime (i.e. akin to a quantum meruit claim) at Article 472.
Of particular note, Article 471(3) provides that if the contractual balance of a lump sum Muqawala contract “collapses due to general exceptional circumstances” that were unforeseeable then the court (or arbitral tribunal), to redress the balance, has the power to extend the performance period for the contractor, adjust the remuneration or terminate the contract.
The KSA Civil Code includes further provisions regarding the contractor’s ability to subcontract its works and the limited circumstances in which an employer could be liable to such subcontractors.[21]
It also provides for specific provisions relating to termination of a Muqawala contract at Articles 475 to 478, in addition to the general provisions for termination of contracts, which we discuss in the fourth article in this series.
Overall, the new provisions in the KSA Civil Code will provide both contractors and employers greater certainty in their dealings, and so should help to reduce the scope for disputes on construction projects. That said, parties on a project of any significant scale should expect to have to deal with claims for additional time and/or money, and so it will be important to understand how such claims may be affected by the provisions under the new law.
Shearman & Sterling, in association with the Law Firm of Dr. Sultan Almasoud, provides advice and advocacy to companies across multiple impact areas. We would be pleased to answer any questions or to provide further analysis on the new KSA Civil Code.
[1] Introducing the New KSA Civil Code and The New KSA Civil Code: Forming a Contract
[2] Article 95(1).
[3] Article 41(1).
[4] Article 41(2).
[5] Article 29(1).
[6] Article 29(2).
[7] Article 179(4).
[8] Article 179(1).
[9] Article 179(2).
[10] Article 179(3).
[11] Article 97(1).
[12] Article 97(3).
[13] Article 97(2).
[14] Article 114.
[15] Article 463(1).
[16] Article 463(2).
[17] Article 466(1).
[18] Article 466(2).
[19] Article 468.
[20] Article 469(1).
[21] Articles 473 and 474.
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Mergers & Acquisitions
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*Partner in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud
Riyadh
Partner
Mergers & Acquisitions
+ 966 11 213 7806
*Partner in the Riyadh office, which we operate in association with The Law Firm of Dr. Sultan Almasoud
Riyadh
With thanks to Aseel Alkathiry and Samuel Honnywill for their assistance in preparing this article.
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